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Taxing Passive Income: The Active Conversation in Kansas

Throughout the typical financial lifetime, many individuals are generally focused on generating active income. This means working around the clock to earn a paycheck to help build up a healthy nest egg. The road less traveled, however, involves letting your money work for you. When it comes to “passive” income, the investment of time and money are purely up front, allowing the beneficiary to accrue the benefits later. But when considering tending to your passive money tree, where do taxes come into play?

Being Actively Passive

The IRS describes passive income types as either rental payments, or the returns from a business in which you do not participate materially. These sources continue making deposits to your account with only initial substantial effort on your part.

For example, blogger and podcaster Pat Flynn, the creative mind behind SmartPassiveIncome.com, generated $3 million in 6 years off of passive income through his creation of a food truck company and multiple helpful websites. According to Flynn, when it comes to passive income “we don’t trade time for money. Instead, we… invest our time upfront creating valuable products and experiences. We work hard now to continually reap the benefits later.”

Is There aPassiveIncome Tax?

Passive income is just as taxable as active income, depending on the jurisdiction. However, as slow economic growth and a comparatively weak business climate cause government commitments to grow faster than revenue, more states are turning their eyes toward establishing, or increasing, taxes on passive income.

One of those states is Kansas, where the state legislature is discussing Senate Bill 260, which could hike taxes on passive income by $115 million in the next two years to help close a budget gap now estimated to be as high as $600 million.

Only three years ago, a Kansas state law passed that excluded passive income from being lumped in with federal AGI. Since then, the Bureau of Labor Statistics has reported “the largest over-the-month percentage increases in employment occurred in Kansas, South Dakota, and Utah (+0.7 percent each).” In addition, Forbes reports Kansas employment growth in the private sector along with higher hourly wages since these 2012 tax cuts, stating “Growth through job creation, reducing taxes on income, and fiscal restraint are the critical pieces in this economic brainteaser.”

Actively Looking at the Kansas Tax Hike

With passive income back on the table for tax discussion, Sen. Les Donovan, chairman of the Senate Assessment and Taxation Committee, recognized the discomfort this creates for some legislators and business leaders in Kansas. However, according to The Garden City Telegram, Donovan stated, “We’re going to be looking at things like this [that are] distasteful to people. We don’t have any choice.”

Of course, that’s not what the Kansas Chamber of Commerce, the National Federation of Independent Businesses and the Kansas Policy Institute believe. According to The Topeka Capital-Journal, they “denounced the bill as unquestionably premature and potentially unnecessary.” They see the bill as an additional burden on taxpayers, one that comes from an unclear picture of the budget as a whole after reductions are made in other areas.

Movement Away From Kansas

When taxes are raised on passive or active income, acquiring it becomes more expensive. This has the potential to drive those who depend on it out of Kansas and into friendlier tax locations. According to How Money Walks, between 1992 and 2011, a total of $3.36 billion in AGI moved out of Kansas to income tax-free states like Texas ($995 million) and Florida ($761 million). Some project that income tax hikes, like the one being discussed in Kansas, will only progress this outward migration of income.

In the end, there is a great difference between active and passive income, and neither is “easy” to accumulate. Being able to keep that money in your bank account or retirement fund is becoming more of an active effort as legislation continues to evolve in states such as Kansas.